APRA to plan for worst case scenario

The prudential regulator will be in charge of drawing up the final stages of the “living wills" of banks, which might not even be told how they will be broken up and sold off in the event of a looming collapse.

The Financial Stability Board, which is co-ordinating reforms to the world’s banking system, released a paper yesterday detailing how it expects national bank regulators to plan in advance for the failure of any bank that is “systemically important" to an economy.

The Australia Prudential Regulation Authority told the big four Australian banks last week they would have to comply with the reform, which could prove expensive should they have to overhaul their corporate structures to ensure they can wind down their operations quickly and easily.

Known more formally as “recovery and resolution plans", such living wills will require banks to specify their risks and draw up contingency plans to fix problems.

In its consultation paper, the Financial Stability Board said “stress tests should be sufficiently severe" and options for recovery “should be concrete and practical".

The plans must be split into two parts – with a recovery phase, for when a bank “remains in principle under the control of its management", and a “resolution phase" for when it is destined to collapse and management passes to the regulator.

The board said essential elements of the recovery phase should include when the bank would conserve or raise more capital as well as identify the ­possible sale of subsidiaries.

While banks would be responsible for developing and maintaining their recovery plans, which will then need to be approved by regulators such as APRA, it will up to regulators to design and implement a bank’s ­resolution plan.

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Regulators may discuss resolution plans with banks “to the extent they believe is useful and confidentiality is not necessary to preserve . . . effectiveness," the board said in its paper. However, a regulator may decide to keep the plan confidential.

Despite this, banks would have to help regulators draw up plans for their demise, and should expect the preparation of such plans to become an integral part of regulators’ supervision.

The major banks and APRA have so far declined to comment on the reform. But
Bendigo and Adelaide Bank
chief executive
Mike Hirst
yesterday backed the idea of making the major banks plan for the worst.

“There were a lot of lessons learnt from the global financial crisis and if the regulator thinks that will stand them in better stead should there be another significant shock to the economy, then why not?" he said.

APRA has not asked Bendigo Bank to draw up such a plan.

Major banks in Britain, the United States and Canada have already begun preparing living wills, a process advisers warn could prove expensive.

In some instance banks may need to overhaul their corporate structures to ring-fence core businesses from smaller, riskier ones and to make them easier to separate and sell off.

One analyst likened such restructures to the moves by Macquarie Group and Suncorp to introduce non-operating holding companies over their various business units, a process aimed at better use of capital.

The Financial Stability Board has also raised the prospect of making countries agree to put depositors at the top of the hierarchy of creditors in the event of a bank going under.

This would in effect bring the rest of the world around to the approach taken in Australia and five other countries, where depositors are first in line ahead of other creditors to get their money back.